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There are situations with factoring in which there is a critical mass of accounts, well over $250,000, where the possibility of shared collateral is sometimes utilized. It requires the absolute full cooperation of two lenders but the possibility exists and has been put to use in many occasions.

The term is called a carve out between two lenders. The first senior lender is usually a bank with a significant line of credit or term loan in place and is using the business assets as collateral. The second lender comes along after the borrower realizes it needs additional working capital to keep the business growing.

The need for having two separate lenders is based on the weakness of the financial condition of the borrower whereby the bank is not interested in furthering their commitment in loan value. Probably the borrower is not really considering the details, they only need more capital to keep going.

To explain what the carve out accomplishes here is a scenario where it would play out; the borrower company owns their own building and has $500,000 of current accounts receivable. The bank has a first position on the real estate and the accounts. A factoring company would propose that an inter-creditor agreement between the bank and the factor would allow the factor to have a first position on a portion of the accounts, for instance $100,000. This would allow the factoring of the first $100,000 of accounts which could give the borrower some badly needed breathing room.

One caveat that is often misinterpreted, the carve would be based on a dollar amount rather than particular customer accounts. Should one of those customers default, the factor would have no method to reclaim its advance. Using a dollar threshold instead gives the factor the ability to collect where needed to get paid off.

This is a highly technical and complex set of negotiations so if you think you might be a candidate for the sharing of accounts, please contact Creative Capital Associates for further consultation to see if the proposed scenario is feasible.

Recently I was writing in a discussion forum with some accountants about the use of accounts receivable factoring and specifically how the work being performed by our clients must be completed and accepted. Submitting invoices for funding prior to the product being delivered or the service being completed is called “pre-billing.” For example, products being shipped in stages, you cannot invoice for the entire shipment sold until it all reaches the customers’ destination.

The reason pre-billing is an issue and why a factoring company will not fund those invoices is the potential for the customer to refuse to pay the invoice because they did not receive their complete order. And should this end up in a legal situation, the factor needs to win in court on a collection action. Without proof that the service has been fully rendered or the purchase order fully received, the court will be reluctant to side with the lender. A factoring company has to verify their collection rights are solid in order to mitigate the risk involved in making an advance on accounts.

Because the verification process of contacting the customer to make sure the invoice is live, the collection issue is rarely invoked. It only means a pre-billed invoice will not be funded until the work is completed.

What sort of business will benefit from accounts receivable factoring? To start with, a company that is in an urgent situation. Because you can find out if you qualify for factoring almost immediately. The paperwork involved is not particularly demanding on straight forward business models. Ultimately it relies on the strength of the customers. How credit worthy are those invoices?

Next, factoring is great for a business owner who is reluctant to have an outstanding loan liability hanging around. Because we handle each advance on an account individually, once the invoice is paid the obligation is finished and there is no subsequent loan to be paid off.

But the biggest benefit of receivable factoring is that is grows with the business. It may start out as a modest funding arrangement, but as the company grows and lands more accounts and the invoices begin to grow, the factor grows right along with those accounts. There is no need to reapply for an increase in the financing availability. This can be helpful to startups but it also works well for a company that is coming out of a slump and is ramping back up after a period of stagnation.

Overall using receivables to fund a company is another tool in the arsenal of a business owner who understands the simplicity of the factoring process.

Many small business owners are still confused about factoring their accounts receivable. It is important to know what a commercial invoice is, because a real invoice is the only method to get funded using factoring. The factoring company has to be able to make an advance on a debt due from an account debtor, or customer. So whether your company provides a product or service, the work has to be completed, accepted and the amount owed has to be verified as due and owing without set-offs or credits. No pro forma, or pre-billing, where your customer may allow a receivable to be generated before the work has been done. This is unacceptable for financing in terms of factoring. Remember the customer’s account must first be checked for their credit rating using an independent credit service.

The bottom line is; the factoring company must be able to independently collect on the receivable if necessary to insure its payment. Hypothetically the factor will have a clear case if it should come to a collection action. Make sure you have properly set up the business relationship with your customers in regards to issuing new receivables to help secure commercial factoring.

Whenever you set payment terms for your customers you become the banker. If you set terms, you are extending credit. How do you make your credit decisions? Anyone with no credit will buy lots of something on credit. By creating large invoices for completed work to a customer who has no chance of going to a bank and securing financing you are essentially saying that you are smarter than the average banker.

Part of the factoring process is to make a credit decision on every invoice. We provide this to you as part of our service. It enables you to make an informed decision when deciding whether to give credit terms to a customer. You would be surprised to find that even well known companies have credit issues and are not good account debtors. Too many times we see a company come to us with a very large outstanding invoice that has no chance of being paid.

Do the homework upfront, let us check their credit before giving them terms.

The concept of lending is not limited to lenders. When you, as a company, provide payment terms to a customer, you are essentially lending short term capital. Your customer has received the goods or services and now you are waiting to get paid. Your loan document happens to be the invoice.

Too many times a business that makes a sale is counting its profit rather than checking out the customer. Getting stiffed on a large order can mean eating a years worth of profit – meaning you worked for a year for free. The stakes are really high, so the decision to extend credit terms is plenty important.

With an invoice factoring arrangement in place, we provide a layer of credit management to keep you out of credit trouble. Every new account debtor or customer gets checked for their creditworthiness. We check public records and filings to determine the customer’s ability to pay.

Important tip: always photocopy the incoming payments from all your customers. Over time this may provide good data for determining the payment history of a good customer. We take this sort of payment history into consideration when scoring credit.

When factoring your receivables, you maintain complete control of the use of funds. Unlike other forms of funding, for instance investment capital, we don’t tell you what you can do with your money or ask questions about the direction of your business. You are free to come and go as you please and choose what and when you want to fund.

Unlike some factoring companies we do not require you to fund all your receivables. You choose which customer accounts and which invoices you need to submit in order to keep your cash flow optimal. The mechanics of the funding process are easy to explain and implement for your added benefit.

The nature of invoice factoring lends itself to company owners who would like to retain control of the business and not have to answer to partners who might one day have designs about new ownership.

Some companies who utilize invoice factoring only want to use it as needed. This means they want the choice of picking and choosing which invoices to finance. There are many factoring companies that set up the account to factor every invoice. They want complete control over the entire accounts receivable base. We DO NOT require this; you are free to choose which invoices you want to submit for funding.

There is a logistical issue though when deciding which customer accounts to finance. Once you determine that a particular customer account is suitable for receivable factoring all payments made by that customer will have to come directly to us for processing. The reason for this is, the accounts payable department of your customer will not be able to properly keep track of which invoices are paid to each ‘remit to’ address. So to simplify the interaction, once you have chosen a particular customer, all payment instructions are made to go directly to us. As a payment is received and we see that it is an ‘unfactored’ invoice – one you did not submit for funding, we turn 100% of that payment back to you without deducting any fees.

In the prior post we talked about direct payments to the factoring company. When a client purposefully or otherwise tells the customer to pay them instead of following the instructions to pay the factor, this is called ‘mis-direction’ of funds. This will cause a default of the factoring agreement. Mis-direction is the severest no-no in the factoring world. The factoring agreement will allow the factoring company to immediately call each and every one of your customers and demand that all payments owed to your company be paid directly to the factor. Mis-direction is simply not tolerated and is penalized severely.

Yes, from time to time a customer will mistakenly send a payment to the wrong address. The proper procedure in these cases is to contact the factor, photocopy the check and overnight it to the proper ‘remit to’ address in care of the factoring company. It’s only in egregious situations when the client has been withholding information that they deposited the customer payment long ago that those severe remedies are called into action. Having financed so many invoices over the years, it is pretty easy to spot the bad magician who thinks they can get away with a little mis-direction.

In the previous post we discussed the essence of invoice factoring. The factoring company buys outstanding business loans in the form of invoices. The critical part of this transaction is determining that the loans are actually worth buying.

• Is the company who is directly paying the invoice creditworthy?
• Has the work been completed 100% and accepted?
• Are there any previous offsets or credits going to be deducted from the payment?
• Does any other entity have existing title to unpaid invoices?
• Will the account debtor (customer) acknowledge the outstanding loan (invoice?)

The job of the factor is to insure that all of the above has been accurately checked out in order to safely provide the capital on the transaction. Usually this process is handled seamlessly with little distraction to the daily operation of your business. But you will notice that these checks are extremely important to any company whether using receivable factoring or not. So we see this as providing much more than capital as a service. Our goal is to keep your company safe and secure when it comes to incoming revenue.

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